Monday, 24 October 2011

Tax too high", shouts taxpayer. Well, blow me down. But the Business Council president, Graham Bradley, had a valid point this week when he complained Australia's carbon price, starting at $23 a tonne and ratcheting up, was "one of the highest costs of carbon anywhere on the planet". It's true, and the government will be hoping things don't stay that way for long.

Australia's carbon price fixed for three years, then floating from July 1, 2015 was meant to start roughly in line with the international market price. But in June Europe's carbon price fell out of bed, as the euro zone sovereign debt crisis deepened, dropping from its two-year, post-global financial crisis level of about €12 to €14 ($16 to $19) per tonne to roughly €7 to €10 per tonne this week. The stronger our currency, the worse that gap looks.

The price drop shows Europe's emissions trading scheme is working: if the economy weakens, emissions fall, and staying under the scheme's emissions "cap" gets easier and cheaper. No one knows if, when or how Europe will resolve its debt crisis and pull itself back into recovery. It could take awhile. On either side of the Atlantic, we might be looking at a lost decade of low growth, Japanese-style.

Worse, there is little certainty about international climate negotiations and what might follow the Kyoto Protocol when it expires at the end of 2012. The protocol establishes the "clean development mechanism", which itself establishes an international carbon price, by allowing liable parties in the developed world (Europe, mainly, because it is doing the most on climate change) to buy their emissions reduction in developing countries.

One way or another most people, according to BloombergNew Energy Finance analyst Seb Henbest, expect the clean development mechanism to continue beyond 2012. But at some point a big chunk of demand for credits under the mechanism is going to be withdrawn again, depressing the carbon price because the European Union has put a ceiling on the amount of emissions reduction it can buy internationally: 1.68 Gt between 2008 and 2020.

Other jurisdictions will enter the market Australia from 2015-16, when we float the price and link up with the rest of the world, and China, Japan and South Korea are working on their own emissions trading schemes and this is likely to push the carbon price up. A massive reduction of deforestation in developing countries, or cheap solar, or a myriad of innovative ways to cut emissions could keep the price down. And what about peak oil? With so many countervailing forces and markets that are artificial and relatively immature, it's very hard to predict where the international carbon price will go.

One thing's sure, climate change is going to get worse and emissions reduction trajectories will get only steeper. That will push the carbon price up, inevitably. Henbest is philosophical. "It's not a matter of whether the government has set the starting price too high or too low. The international price moves, they can never get that right. It's always going to be wrong in one direction or the other".

Our starting price is the result of a political negotiation, there is no science behind it. If the price starts too high in the first three years, and drops sharply once it floats, what are the consequences? Deloitte's study for the Business Council warned of the risks to the government's revenue, meaning the scheme might not be budget neutral.

For business, the risk seems less clear. Deloitte included broker forecasts that the international carbon price would range between $22.38 and $34.02 per tonne in 2015-16, by which time our price would be around $29. The council warns the high fixed price means a "hard start" for Australian industry and it wants a lower initial price. But the emissions-intensive, trade-exposed sector is getting compensation via free permits of between 66% and 95%, then tapering off. Other businesses will pass on higher costs mainly dearer gas and electricity with overall consumer prices expected to rise by 0.7% in the first year according to the government's figures. Most households get compensation for that price increase.

This year the Grattan Institute updated its modelling on the impact of a $40 per tonne carbon price on industry and households to account for the rise in our dollar and other input costs as well as higher commodity prices. The analysis assumed no carbon price anywhere else in the world. The answer", Grattan economist Tristan Edis says, "is that the vast majority of Australian industry will see little if any change to their financial viability. In fact some industries, such as steel, will be better off". Next year, he says, "July 1 will roll over and the scheme will start and the vast majority of the country won't even notice. The only people that will notice will be electricity generators".

Climate change adviser Ross Garnaut acknowledges the international price has been below the fixed price of $23 a tonne for several months "after having be en well above it for quite a while". He, too, plays down the impact: "It may be higher or lower when the scheme starts next year. The differential won't be large either way. Any negative differential for Australian trade-exposed industries will largely be offset for the emissions intensive by free permits. Knowledge that any differential is likely to be removed by international trading makes it unlikely that the small remaining differential will be influential in important investment decisions".

Which is one way of saying, tough. Neither the government nor the Greens are open to changing the starting price. A spokesperson for the Greens Deputy Leader, Christine Milne, warned that by 2015-16, if the carbon price was still at rock-bottom prices, we'll be in serious trouble: "We have to have a global price which is thoroughly recovered and on its way to growing substantially by that point in time if we're to avoid the climate crisis that is coming down the line".